The New York Times reports, On Wall Street and in bank boardrooms, the question of whether investors can force banks to buy back, or "put-back," the bad mortgages to the banks that sold them is dominating the debate and worrying analysts, money managers and banking executives. The story says that the Federal Reserve, which now owns a lot of mortgage securities, may be joining the put-back crowd.
When mortgage lenders sell loans to Freddie Mac and Fannie Mae, they make "reps and warrants" (representations and warrants) that the loans comply with rules and guidelines. If a loan is later found not to be in compliance, the lender is required to buy it back.
This is just one of the many mechanisms within the securitization process that are designed to address the principal-agent problem. We are seeing evidence of this problem everywhere, including in the foreclosure mess.
Since the financial crisis began, I have been inclined to think that we need to go back to traditional mortgage lending and stop trying to use government policy to sustain the securitization model. Each month, the principal-agent costs seem to mount, adding to the disadvantage of securitization.
To me, it is obvious that the overall costs of the securitization model are high relative to the costs of traditional lending. But what is obvious to me is unthinkable in the two places that matter--Wall Street and Washington.
Are there some common issues to the mortgage secularization fiasco and medicare/medicaid?
One that comes to mind is the importance of distributed private information in dealing with inherently complex domains. Secularization distilled the decision process down to a few (not so simple?) rules. Many of the fixes seem to be little more than patching the rules without leveraging distributed/local knowledge. (e.g. as opposed to requiring the loan originators keeping and maintaining the mortgage)
In medical care, is this the trend? Will it get better or worse? Surely benefits of procedures can vary widely, a mean, median, or mode is not sufficient information for an individual decision. How are costs allowed to vary?
Bill N: Did you really mean "secularization"? I assume not.
"Securitization"
Thanks for that catch. Ouch, spell checkers.
No problem. If I was in charge of an economics blog spellchecker, I'd make sure "securitization" was in there. :)
To the original post: so why is roll-back the answer? I mean, caveat-emptor, right? The entities that bought MBSs were not widows and orphans. They were generally sophisticated.
Peter, When, say, Freddie, buys a mortgage from Sleeze-E Mortgage Banking Corp., the contract says that the loan was underwritten to certain standards. Freddie does not at that time check to see if it was underwritten to those standards, because that is too expensive. Later, if it does a random audit on that loan, or if the loan goes bad quickly and as a result they decide to do an audit, that audit may turn up violations of the standards. At that point, whether the loan is performing or not, the contract says that Freddie can require Sleeeze-E to repurchase the loan.
My guess is that some provision like that exists in all securitization contracts. Otherwise, you would have to re-underwrite every loan at every step in the process.
Yeah, poor Freddie. They obviously didn't know what Sleeze-E Mortgage was doing. They had no incentive to ignore the flaws in the process.
I'm not saying they don't have a legal out here. I am not a lawyer.
Sleeze-E mortgage is clearly not blameless in your hypothetical, but neither is Freddie.
I'll put it another way and try to soften my tone:
In my experience, these things are not decided based on how a normal human would read a single line in a contract. There's often enough blame to go around, and a judge, jury or arbitrator is going to have to be convinced of the reasonableness of a solution, or a settlement that is not-too-disagreeable to both parties will have to preempt an imposed solution.
These big disputes are not normally resolved by "Perry Mason Moments" in which one key fact is uncovered in court.
I think you're right.
If securitization was really the way to go, you'd think that diligence would get progressively streamlined and loan documentation easier to check. That's not what happened at all, the principal-agent gap widened substantially instead.
Unless, of course, there's a legal barrier here as there is with titles. Certain aspects of portable diligence would likely violate privacy rights, especially once shaped into a database of complete credit information.
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